Monday, March 29, 2010

An interesting question raised by Bloomberg - are the assets gained by John Paulson after the now infamous bet against the US subprime market, getting to a point that it will be impossible to truly outperform the market / peers? We saw earlier this month that Paulson now is the 3rd largest hedge "fund" [Mar 8, 2010: List of Largest Global Hedge Funds] at some $32 billion but in actuality this is more than 1 fund. That said, there are only so many opportunities out there where the footprint left by this amount of money won't be noticed... perhaps part of the reason of the moves into gold [May 16, 2009: John Paulson Continues to Pile Into Gold] and one of the companies with the most shares in the world. [Aug 26, 2009: Citigroup Surges on John Paulson Investment] With his concentrated style it will make it even more difficult than for the average hedge fund. I guess we will find out the answer to these questions in about 3 years.

John Paulson started the year overseeing $32 billion in hedge funds, third in the world behind JPMorgan Chase & Co. and Bridgewater Associates LP. Unlike many of his biggest rivals, he’s taking in new cash, raising the question of how much money is too much for a hedge-fund manager. “As with all managers that bulk up, there’s always the risk of returns becoming mediocre.”

Paulson & Co., the New York-based firm that the former Bear Stearns banker and Gruss Partners trader started in 1994, differs from many large competitors because it makes concentrated bets, such as the wager against subprime mortgages that helped generate $3 billion of profit in 2007. While New York-based JPMorgan and Bridgewater of Westport, Connecticut, are larger than Paulson’s firm, they tend to make comparatively smaller bets.

As assets increase, it can get harder for a fund to find investments big enough to drive returns and to trade without distorting prices. Paulson’s main $19 billion Advantage funds, which primarily seek to profit on distressed debt, bankruptcies and mergers, have lagged behind peers this year and last after beating them in 2007 and 2008. Today, he has 10 percent to 15 percent of his Advantage funds in the shares of gold-mining companies on the expectation that prices of the metal will rise along with inflation.

In 2009, the Advantage Plus fund climbed 21 percent, compared with about 25 percent for peers. Through February 2010, it lost 1 percent, compared with a gain of 1 percent for similar funds. The Credit Opportunities funds climbed 35 percent last year, and are up 0.35 percent this year.

Paulson continues to market his funds because he sees opportunities in the next 18 months to 24 months as companies restructure their debt. The unleveraged version of the Advantage fund is targeting returns of 12 percent to 15 percent, he said.

Fourteen firms managed $20 billion or more in hedge funds at the start of 2010, when industry assets stood at $1.6 trillion. Hedge funds oversaw a record $1.9 trillion in mid- 2008. In 1998, only George Soros’s Soros Fund Management LLC and Julian Robertson’s Tiger Management LLC exceeded the $20 billion mark. Within two years of hitting that milestone, both firms had suffered big losses and decided to stop managing money for other investors.

“There is a point where you can be too big to generate returns,” said Lawrence P. Chiarello, a partner at Red Bank, New Jersey-based SkyView Investment Advisors LLC, which selects hedge funds for clients. “Being large and able to build a strong infrastructure are good things, but in general I think the pendulum has swung too far.”

In 2008, Chicago-based Citadel Investment Group LLC, whose assets had climbed to about $20 billion, lost 55 percent in its biggest funds after wagers on convertible, high-yield and investment-grade bonds hedged with credit-default swaps all went awry. It managed about $12 billion at Dec. 31.

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